STATE OF NORTH CAROLINA OFFICE OF THE STATE AUDITOR BETH A. WOOD, CPA

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1 STATE OF NORTH CAROLINA OFFICE OF THE STATE AUDITOR BETH A. WOOD, CPA ALCOHOLIC BEVERAGE CONTROL COMMISSION ALCOHOLIC BEVERAGE CONTROL COMMISSION WAREHOUSE CONTRACT PERFORMANCE AUDIT AUGUST 2018 The key findings and recommendations in this summary may not be inclusive of all the findings and recommendations in this report.

2 EXECUTIVE SUMMARY PURPOSE The purpose of this audit was to determine whether the Alcoholic Beverage Control Commission (Commission) procured, administered, and monitored the LB&B Associates, Inc. (LB&B) contract for the warehousing and distribution of spirituous liquor in accordance with state policies and best practices. BACKGROUND The Commission has the responsibility to oversee and provide a uniform system of control over the sale, purchase, transportation, manufacture, consumption, and possession of alcoholic beverages in North Carolina. Historically, the Commission has contracted with a vendor to warehouse and distribute spirituous liquor. LB&B has been contracted to provide these services since In state fiscal year 2017, the contract cost for warehousing and distributing spirituous liquor was $8.3 million. The total contract cost from July 2004 through June 2017 was $77.7 million. KEY FINDINGS The Commission did not procure, administer, and monitor the LB&B contract for the warehousing and distribution of spirituous liquor in accordance with state policies and best practices. Poor contract administration cost the State at least $11.3 million over 13 years Unused warehouse space potentially cost the State $2.1 million over 7 years No monitoring left the State underpaid by at least $297,537 over two years KEY RECOMMENDATIONS The Commission should procure, monitor, and administer contracts in accordance with state laws and regulations and the contract terms The Commission should review and validate the reasons given for all requested contract amendments and price increases prior to authorization The Commission should obtain the Division of Purchase & Contract s review and approval when the contract term, including extensions and renewals, will exceed three years The Commission should reassess its warehouse space needs and determine if costs can be reduced The key findings and recommendations in this summary may not be inclusive of all the findings and recommendations in this report.

3 STATE OF NORTH CAROLINA Office of the State Auditor Beth A. Wood, CPA State Auditor 2 S. Salisbury Street Mail Service Center Raleigh, NC Telephone: (919) Fax: (919) AUDITOR S TRANSMITTAL The Honorable Roy Cooper, Governor Members of the North Carolina General Assembly Alexander Guy Jr., Chairman, Alcoholic Beverage Control Commission Erik Hooks, Secretary, Department of Public Safety Ladies and Gentlemen: We are pleased to submit this performance report titled Alcoholic Beverage Control Commission Warehouse Contract. The objective of this audit was to determine whether the Alcoholic Beverage Control Commission procured, administered, and monitored the LB&B Associates, Inc. contract for the warehousing and distribution of spirituous liquor in accordance with state policies and best practices. The Alcoholic Beverage Control Commission s Chairman reviewed a draft copy of this report. His written comments are included starting on page 18. This audit was conducted in accordance with Article 5A of Chapter 147 of the North Carolina General Statutes. Respectfully submitted, Beth A. Wood, CPA State Auditor

4 TABLE OF CONTENTS PAGE BACKGROUND... 1 OBJECTIVE, SCOPE, AND METHODOLOGY... 3 RESULTS AND CONCLUSIONS... 4 Beth A. Wood, CPA State Auditor FINDINGS, RECOMMENDATIONS, AND RESPONSES POOR CONTRACT ADMINISTRATION COST THE STATE AT LEAST $11.3 MILLION OVER 13 YEARS... 5 UNUSED WAREHOUSE SPACE POTENTIALLY COST THE STATE $2.1 MILLION OVER SEVEN YEARS... 9 NO MONITORING LEFT THE STATE UNDERPAID BY AT LEAST $297,537 OVER TWO YEARS MATTERS FOR FURTHER CONSIDERATION APPENDIX STATE AUDITOR S RESPONSE RESPONSE FROM THE ALCOHOLIC BEVERAGE CONTROL COMMISSION ORDERING INFORMATION Article V, Chapter 147 of the North Carolina General Statutes, gives the Auditor broad powers to examine all books, records, files, papers, documents, and financial affairs of every state agency and any organization that receives public funding. The Auditor also has the power to summon people to produce records and to answer questions under oath.

5 BACKGROUND

6 BACKGROUND North Carolina is one of 17 control states. 1 North Carolina is a "local option 2 state with 167 local Alcoholic Beverage Control (ABC) boards operating the 428 retail ABC stores that sell spirituous liquor 3 to individual consumers or businesses in the State. 4 The Alcoholic Beverage Control Commission (Commission) 5 has the responsibility to oversee and provide a uniform system of control over the sale, purchase, transportation, manufacture, consumption, and possession of alcoholic beverages in North Carolina. Chapter 18B of the North Carolina General Statutes grants and charges the Commission with its responsibilities. Specifically, the Commission is responsible for: Administering the ABC laws Providing for enforcement of the ABC laws Setting prices of spirits sold in ABC stores Determining brands of alcoholic beverages sold in the State Serving as wholesale distributor of spirituous liquor Contracting the State ABC warehousing of spirituous liquor Overseeing local ABC boards Issuing ABC permits Imposing sanctions against businesses holding ABC permits that violate the law Promulgating rules The Commission currently consists of two members, a Chairman and Commissioner. 6 The Chairman and Commissioner report to the Governor and are responsible for setting the policy of the Commission. Between 2004 and 2017, there have been four Chairmen of the Commission. The current Chairman was appointed by Governor Roy Cooper in March The Commission employs a Chief Administrator and 50 staff members. The Chief Administrator reports directly to the Chairman and Commissioner and is responsible for all day-to-day operations as well as for the administration and oversight of the warehouse and distribution contract. The current Chief Administrator has been in this role since January 2015, and the prior Chief Administrator held the position since Historically, the Commission has contracted with a vendor to warehouse and distribute spirituous liquor. LB&B Associates, Inc. (LB&B) has been contracted to provide these services since A control state prohibits the sale of liquor in private stores, limiting it to government-owned outlets only. A local option gives a city or county the authority to establish ordinances for the sale of malt beverages, unfortified wine, and fortified wine. Spiritous liquor refers to an alcoholic beverage that is produced by a distiller. According to the Commision s 2017 Annual Report. The Commission is an agency administratively located within the North Carolina Department of Public Safety but exercises its powers independently of the Secretary of Public Safety. Commission members are appointed by the Governor to serve at his pleasure. 1

7 BACKGROUND LB&B is a facilities management, logistics, and training company headquartered in Columbia, Maryland. It employs nearly 1,000 employees across the United States and maintains more than 65 contracts at any one time performing services for the federal government, state government, and private clients. 7 Approximately 70 employees are dedicated to the North Carolina s warehousing and distribution of spirituous liquor contract. Since the assignment of the warehousing and distribution of spirituous liquor contract to LB&B in 2004, there have been 12 amendments to the contract that have retained LB&B as the State s vendor and made changes to the price and/or contract terms. 8 In state fiscal year 2017, the contract cost for warehousing and distributing spirituous liquor was $8.3 million. 9 The total contract cost from July 2004 through June 2017 was $77.7 million According to Amendments were approved and executed under four separate Commission Chairman and two Commission Chief Administrators. 9 According to contract. Contract payments were verified by auditors. 10 Figures according to the Contract; this value does not include additional revenues collected by LB&B from boards and distillers for additional services in relation to the Contract. Contract payments between 2004 and 2015 were not verified by auditors. 2

8 OBJECTIVE, SCOPE, AND METHODOLOGY

9 OBJECTIVE, SCOPE, AND METHODOLOGY The objective of this audit was to determine whether the Alcoholic Beverage Control Commission (Commission) procured, administered, and monitored the LB&B Associates, Inc. (LB&B) contract for the warehousing and distribution of spirituous liquor (Contract) in accordance with state policies and best practices. The audit scope included the Commission s procurement and administration of the contract during state fiscal years (SFYs) The audit scope also included the Commission s monitoring and oversight of the contract, including LB&B s performance under the contract during SFYs 2016 and To accomplish the audit objective, auditors interviewed personnel, observed operations, reviewed policies, analyzed records, and examined documentation supporting transactions, as considered necessary. Whenever sampling was used, auditors applied a nonstatistical approach. Therefore, results could not be projected to the population. This approach was determined to adequately support audit conclusions. Because of the test nature and other inherent limitations of an audit, together with limitations of any system of internal and management controls, this audit would not necessarily disclose all performance weaknesses or lack of compliance. As a basis for evaluating internal control, auditors applied the internal control guidance contained in professional auditing standards. However, our audit does not provide a basis for rendering an opinion on internal control, and consequently, we have not issued such an opinion. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. 3

10 RESULTS AND CONCLUSIONS

11 RESULTS AND CONCLUSIONS The Alcoholic Beverage Control Commission (Commission) did not procure, administer, and monitor the LB&B Associates, Inc. (LB&B) contract for the warehousing and distribution of spirituous liquor in accordance with state policies and best practices. 4

12 FINDINGS, RECOMMENDATIONS, AND RESPONSES

13 FINDINGS, RECOMMENDATIONS, AND RESPONSES 1. POOR CONTRACT ADMINISTRATION COST THE STATE AT LEAST $11.3 MILLION OVER 13 YEARS The Alcoholic Beverage Control Commission (Commission) did not administer the Alcoholic Beverage Control Commission Warehouse contract (Contract) in the best interest of the State. The Commission (1) exceeded the maximum allowable Contract price by $11.3 million over 13 years, (2) approved $5.5 million in contractor requested price increases without verifying reasonableness and necessity, and (3) exceeded the three-year contract term limit four times without proper review and approval which denied the State the opportunity to reduce costs through negotiation and competitive bidding. Exceeded Maximum Allowable Contract Price 13 Years in a Row First, the Commission failed to ensure prudent use of public funds by repeatedly approving Contract price increases that exceeded the maximum allowable amounts stipulated by the Contract. The Contract states, 11 Requested increases shall not exceed the changes in the Average Wages of N.C. Employees in Wholesale Trades [ECI] and/or the Consumer Price Index for Motor Fuels [CPI]. 12 However, the Commission increased the Contract s price by amounts that exceeded the ECI and/or CPI for 13 consecutive years. 11 Per the 2004 contract. 12 Consumer Price Index (CPI) was obtained from the U.S. Department of Labor, Bureau of Labor Statistics. The Average Wage of N.C. Employees in Wholesale Trades was obtained from the N.C. Department of Commerce, Labor and Economic Analysis Division. Both indices were calculated based on state fiscal year to align with the contract. 5

14 FINDINGS, RECOMMENDATIONS, AND RESPONSES As a result, the State incurred approximately $11.3 million more in contract costs than required or allowed by Contract terms and conditions: Contract Price Adjustments Allowable Price Increases and Variance (excess) SFY Price Increase ($) Increase (%) Max Allowed (%) Max Contract Allowed ($) Variance ($) 2004 $ 3,199,780 N/A N/A N/A N/A N/A ,526,412 $ 326, % 4.9% $ 3,357,190 $ 169, ,777, , % 5.7% 3,549, , ,638, , % 4.7% 3,715, , ,638, % 2.5% 3,807, , ,082, , % 2.9% 3,919,360 1,163, ,956, , % 0.0% 3,919,360 1,037, ,066, , % 2.3% 4,010,638 1,055, ,300,000 2,233, % 5.3% 6,456, , ,300, % 3.0% 6,648, , ,700, , % 0.6% 6,687,978 1,012, ,700, % 0.0% 6,687,978 1,012, ,700, % 0.0% 6,687,978 1,012, ,300, , % 0.0% 6,987,978 1,312,022 $ 5,358, TOTAL: $ 11,250,855 The Commission did not explain why it repeatedly approved price increases that exceeded the maximum allowed amounts. But the Commission offered that it had little to no resources dedicated to monitoring the Contract. However, as a state agency, the Commission is responsible for the prudent use of public funds and for obtaining services at the lowest possible costs. The North Carolina State Procurement Manual states: (Emphasis Added) In North Carolina, the central authority over purchasing goods and services for all State departments, institutions and agencies is vested in the Department of Administration, and by delegation, in its Division of Purchase and Contract ( the Division or P&C ) through the State Purchasing Officer. Thus, the Division and by extension, everyone performing the procurement function across State government has primary responsibility for the prudent use of public funds. The purchasing activities of both private enterprise and State government are charged with acquiring suitable good and services at the lowest possible cost. 13 Included one-time lump sum payment in the amount of $258,610 for an increase in the cost of fuel, increase in Warehouseman s Public Liability coverage, and a 3% cost of living adjustment for labor. 14 The 2010 contract included an increase in the amount of $133,000. However, the total contract value was reduced in comparison to 2009 due to a one-time lump sum payment received in 2009 (see FN 13 above). 15 Included one-time lump sum payment in the amount of $250,000 for additional costs associated with an increase in the volume of fuel and volume of cases received, handled, and shipped. 16 Amount does not include $150,000 of price increases authorized for 2019, 2020, 2021 contract years. 6

15 FINDINGS, RECOMMENDATIONS, AND RESPONSES Approved Contract Price Increases without Verifying Reasonableness and Necessity Second, the Commission failed to ensure prudent use of public funds by not evaluating and verifying the reasonableness and necessity of contractor requested price increases before approving them. Since September 2004, the Commission approved 12 price increases to the Contract totaling more than $5.5 million. 17 Evaluation and verification would have been prudent because documentation shows that some reasons given for price increases were not accurate or appropriate to support a price increase. For example: In 2008, the contractor requested an increase based in part 18 on increased fuel costs during However, documents show that the contractor s fuel costs actually decreased by $23,197 in In 2016, the contractor requested an increase based in part 19 on increased fuel usage during However, documents show that the contractor s fuel usage and costs actually decreased by 7,264 gallons and $221,228 respectively in In five separate contract amendments, the contractor requested an increase based in part on an increase in the number of cases of spirituous liquor shipped to local ABC boards. However, according to the Contract, increases or decreases in the volume of cases handled did not obligate the State to adjust the price of the Contract prior to July 1, Because the Commission did not evaluate or verify the contractor s reasons for requesting a price increase, the Commission cannot provide reasonable assurance that over $5.5 million in price increases were reasonable or necessary. The Commission did not perform these tasks because, according to the Commission s Chief Administrator, they believed it was unnecessary to verify the legitimacy of documentation received from the contractor to support increased costs. However, as noted above, the Commission is responsible for the prudent use of public funds and for obtaining services at the lowest possible costs. Exceeded State Contract Term Limits Four Times without Proper Approval Third, the Commission violated state purchasing policy when it executed the Contract for terms of greater than three years without obtaining approval from the Department of Administration, Division of Purchase and Contract (P&C). The Commission then continued to violate state purchasing policy by executing three contract extensions, each exceeding the three-year term limit, without obtaining P&C s review and approval. 17 See Appendix for full list of Contract amendments and price increases. 18 (1) Increased cost and volume of fuel, (2) cost of additional insurance coverage, (3) cost of living adjustment for labor, and (4) the increase in number of cases shipped to local ABC boards. 19 (1) Increased volume of fuel, (2) to allow for additional services from the Raleigh and Clayton warehouses. 20 Beginning July 1, 2016, LB&B is entitled to a lump sum adjustment to the contract price if the number of cases of spirituous liquor shipped by LB&B is at least 5% higher than the number shipped during the preceding 12-month contract period. 7

16 FINDINGS, RECOMMENDATIONS, AND RESPONSES The terms of the original contract and extensions were: October 2003 July 2007 July 2006 June 2011 July 2011 June 2016 July 2016 June The Commission s failure to obtain proper review and approval prevented P&C from ensuring that the contract and extensions were in the best interest of the State. It also denied the State the opportunity to reduce costs through negotiation and a competitive bidding process. According to the Commission, it did not obtain P&C s review and approval because it believed that it was exempt from North Carolina procurement rules. However, neither NC General Statutes Chapter 143 Article 3 (Purchases and Contracts) nor Chapter 18B Article 2 (State Administration) specifically exempts the Commission from state procurement rules. Consequently, as a state agency, the Commission is required to follow the policy contained in the North Carolina Procurement Manual which states: The contract term, or length, shall not be for more than three years, including all extensions and renewals, without the prior approval of the SPO/SCIO or his designee, based on a determination that the longer period is advantageous to the State. (Emphasis Added) RECOMMENDATIONS The Commission should procure, monitor, and administer the Contract in accordance with state laws and regulations and contract terms. The Commission should review and validate the supporting reasons given for all requested contract amendments and price increases prior to authorization. The Commission should obtain review and approval from the Division of Purchase & Contract when a contract s term, including extensions and renewals, will exceed three years. AGENCY RESPONSE See page 18 for the Commission s response to this finding. 21 For the July 2016 contract, the Commission also failed to obtain the Attorney General s review as required by North Carolina General Statute (a). 8

17 FINDINGS, RECOMMENDATIONS, AND RESPONSES 2. UNUSED WAREHOUSE SPACE POTENTIALLY COST THE STATE $2.1 MILLION OVER SEVEN YEARS The Alcoholic Beverage Control Commission (Commission) failed to ensure prudent use of public funds when it authorized the lease of a Clayton warehouse. A large amount of the warehouse space was unused and potentially resulted in $300,000 a year of unnecessary cost over seven years. The Commission did not verify its need for a warehouse of this size, although state policy and best practices required the Commission to perform its responsibilities prudently and economically. Warehouse Space Largely Unused In 2011, the Commission authorized LB&B Associates, Inc. (LB&B) to lease an additional 200,000 square-foot warehouse in Clayton 22 as a five-year short term solution to the Commission s need for additional warehouse space. Adding this warehouse to the Alcoholic Beverage Control Commission Warehouse contract (Contract) doubled the amount of warehouse space available 23 and has increased the cost of the contract by approximately $2.54 million a year on average. 24 However, the warehouse space is largely unused. According to LB&B s 2017 inventory space allocation report, only 23% of the Clayton warehouse space is allocated for regularly listed spirituous liquor. 25 Additionally, auditors toured the Clayton warehouse on three separate occasions 26 and observed large amounts of unused space in the warehouse. The unused space was evident even during the auditors visit during LB&B s admittedly busiest time, the holiday season. 27 The following photos were taken between 12/7/2017 and 12/12/2017 and show how much of the warehouse space was unused during the busy holiday season. 22 Previously, the warehousing and distribution was handled from a single 200,000 square foot state-owned warehouse located in Raleigh. The Clayton warehouse exists in addition to the Raleigh warehouse. 23 From 200,000 square feet to 400,000 square feet. 24 The contract price increased by $2.3 million in the first two years and by $2.7 million in subsequent years. 25 LB&B did not retain space allocation reports for Dates inlude November and December Includes the months of October, November, and December. 9

18 FINDINGS, RECOMMENDATIONS, AND RESPONSES Potentially Resulted In $300,000 of Unnecessary Annual Costs The fact that the Clayton warehouse had this much space available raises the question of whether it was significantly larger than necessary. As noted above, LB&B reports indicated that only 23% (46,000 square feet) of the Clayton warehouse space was allocated for regularly listed spirituous liquor. Consequently, a 92,000 square-foot warehouse may have been sufficient. In 2011, 92,000 square-feet of warehouse space could have been leased in the surrounding area for approximately $272,860 to $337,260 less per year than the Clayton warehouse. 28 With approximately $300,000 a year in unused space, the Clayton warehouse lease potentially resulted in $2.1 million of unnecessary costs over the last seven years. Caused By Commission Not Verifying Reasonableness of Its Short Term Solution The Commission did not document that it evaluated and verified the reasonableness and necessity of leasing an additional 200,000 square foot warehouse as a short term solution to its need for additional space before amending the Contract. On April 14, 2011, the Commission discussed its need for additional warehouse space. The meeting minutes stated: In 2007, the Commission recognized this need and hired a consultant who provided different options for expansion. Unfortunately, the Commission was unable to move forward on any of the options and the past two years started experiencing the problems of managing a growing business in a warehouse without enough space to handle demand. (Emphasis Added) The minutes also note the problems that the Commission associated with the lack of space: To keep up with growth, steps have been taken to discontinue product and reduced allocated space on items. This has resulted in less selection and out of stocks and created issues at the retail level affecting the ABC Boards ability to maximize 28 Based on Triangle Business Journal SFY 2011 warehouse lease information and the SFY 2011 Clayton warehouse lease payments totaling $613,

19 FINDINGS, RECOMMENDATIONS, AND RESPONSES profits by purchase low and selling high when items are increasing in price. It also has led to lost sales at retail. (Emphasis Added) As a short term solution, the minutes note that the Commission approved a recommendation: for the current warehouse contractor, LB&B Associates to put together a short term proposal to lease an additional 200,000 square feet of space at a nearby location for five years until a long term solution can be found. (Emphasis Added) However, there was no analysis or verification that this was the most efficient short term solution. Specifically, the Commission did not document verification of the following: 1. That an additional 200,000 square feet of warehouse space was the minimum amount necessary based on trends and expected growth over the five-year short term Seven years later, only about 23% of the warehouse space is allocated for regularly listed items. 2. That the lack of space was the main reason for being out of stock and under filling orders Seven years later, significant under filling of orders still occurs. In fact, 52% of orders were under filled in state fiscal year (SFY) 2017 and 39% were under filled in SFY 2016 despite the additional warehouse space. Additionally, the Commission did not obtain the Department of Administration, Purchase & Contract Division s (P&C) review and approval, which prevented P&C from ensuring that the short term solution was reasonable and prudent. State Policy and Best Practices Require Prudent Use of Public Funds As a state agency, the Commission is responsible for the prudent use of public funds and for performing its responsibilities economically. The North Carolina State Procurement Manual states: (Emphasis Added) In North Carolina, the central authority over purchasing goods and services for all State departments, institutions and agencies is vested in the Department of Administration, and by delegation, in its Division of Purchase and Contract ( the Division or P&C ) through the State Purchasing Officer. Thus, the Division and by extension, everyone performing the procurement function across State government has primary responsibility for the prudent use of public funds. The purchasing activities of both private enterprise and State government are charged with acquiring suitable good and services at the lowest possible cost. 11

20 FINDINGS, RECOMMENDATIONS, AND RESPONSES Additionally, best practices identified by the Government Accountability Office (GAO) states: Management and officials entrusted with public resources are responsible for carrying out public functions and providing service to the public effectively, efficiently, economically, ethically, and equitably within the context of the statutory boundaries of the specific government program. (Emphasis Added) RECOMMENDATIONS The Commission should review and validate the reasons given for all requested contract amendments prior to authorization. The Commission should reassess its warehouse space needs and determine if costs can be reduced. The Commission should maintain documentation of its analysis, conclusions, and decisions. AGENCY RESPONSE See page 18 for the Commission s response to this finding. 3. NO MONITORING LEFT THE STATE UNDERPAID BY AT LEAST $297,537 OVER TWO YEARS The Alcoholic Beverage Control Commission (Commission) did not monitor compliance with the Alcoholic Beverage Control Commission Warehouse contract (Contract). As a result, underpayments of $297,537 to the State and $12,183 to distillers went undetected. 29 The Commission did not believe that it was responsible for monitoring. However, state policy and best practices require adequate contract monitoring. Commission Did Not Monitor Compliance with Contract The Commission did not adequately monitor LB&B Associates, Inc. (LB&B) compliance with the contract for warehousing and distribution of spirituous liquor in North Carolina. According to the Commission s Chief Administrator, the Commission performed some monitoring such as receiving monthly aging reports for accounts past due and inventory stock status reports from LB&B. However, the Commission did not provide evidence that the reports were reviewed or that any action was taken as a result of any reviews. Furthermore, the Commission did not have: A formal process in place to track fees or a complete set of supporting documents such as collection or disbursement statements 29 Amounts of underpayments to the State based on analysis of available data from LB&B s Macola and Peachtree billing systems. Amounts of underpayments to distillers based on analysis of available data from LB&B s payout reports and inventory reconciliation for losses reports. The Commission was unable to produce original documentation in the timeframe necessary to complete this audit. 12

21 FINDINGS, RECOMMENDATIONS, AND RESPONSES Documentation to reconcile LB&B physical inventory with inventory records and to show how dollar value adjustments 30 and inventory shrinkage fees 31 were determined Reports from LB&B of billings made to local ABC boards and distillers LB&B financial statements specific to its North Carolina operations to show annual warehousing and distribution costs for comparison to the State contract price Resulted in Undetected Underpayments to the State and to Distillers Failure to adequately monitor could allow contract noncompliance and errors to go undetected. For example, the Commission failed to detect that the State did not receive its share of incidental services fees 32 and special services fees. 33 The Commission also failed to detect that LB&B underpaid distillers for inventory shrinkage. Specifically, auditors reviewed two years of fees and found the following undetected errors: State was underpaid $138,395 (30%) in state fiscal year (SFY) 2017 and $37,142 (12%) in SFY 2016 for incidental services fees 34 State was underpaid $69,350 (63%) in SFY 2017 and $52,650 (51%) in SFY 2016 for special services fees 35 Distillers were underpaid $12,183 (20%) in SFY 2017 for inventory shrinkage 36 Any similar errors that may have occurred in previous years would have gone undetected due to lack of monitoring. Caused by Commission s Belief That It Is Not Responsible for Monitoring When asked about monitoring and oversight of the Contract, the Commission s Chief Administrator stated that the Commission did not need to monitor LB&B s activities because any errors made by LB&B would be noticed, addressed, and corrected by a local ABC board or distiller s interaction with LB&B. 30 Dollar value adjustments refers to any adjustment made to the dollar value of inventory. For example, due to an inaccurate count of inventory. 31 Inventory shrinkage fees refer to the cost of inventory that can t be accounted for due to theft or other loss. 32 Incidental services are services provided by LB&B, charged to distillers, and collected directly by LB&B. They include re-palleting, holding of delisted items, recoding merchandise and destroying deteriorated products. According to the contract, incidental services are split 50/50 between the State and LB&B. 33 Special services include additional services provided by LB&B for the benefit of the distiller. Such services include billing, data link communications, shipment summary, and handling of merchandise on slip sheets in lieu of wooden pallets. These additional services are provided for a fee to distillers, and they are in addition to regular merchandise handling such as receipt and storage of inventory. According to the contract, special services are payable 100% to the State. 34 LB&B collected $923,322 (SFY17) and $600,424 (SFY16) in incidental services fees that are 50% payable to the State. But the State only received $323,266 (SFY17) and $263,070 (SFY16). 35 LB&B collected $221,510 (SFY17) and $206,610 (SFY16) in special services fees that are 100% payable to the State. But the State only received $152,160 (SFY17) and $153,960 (SFY16). 36 LB&B paid $49,923 but should have paid $62,

22 FINDINGS, RECOMMENDATIONS, AND RESPONSES However, local ABC boards and distillers do not have the ability to monitor LB&B s compliance with the state contract. Local ABC boards and distillers do not receive LB&B reports or have access to LB&B systems, except for information related to orders. State Policy and Best Practices Require Contract Monitoring Furthermore, as a state agency, the Commission is responsible for monitoring its contracts and complying with guidance issued by the Department of Administration, Purchase and Contract Division (P&C). P&C s Contract and Administration Monitoring Guide states: Each agency is independently responsible for implementing and documenting sound business contract monitoring procedures in this guide, in accordance with applicable state laws, regulations, policies and procedures. The integrity of the public purchasing system demands that goods and services be furnished, received, invoiced and paid as specified in the contract. Tracking the performance of the contractor is the principal function of proper contract monitoring and administration. The purpose is to ensure that the contractor is performing all duties in accordance with the contract and for the agency to be aware of and address any problems or issues promptly. Best practices also require contract monitoring. According to the National State Auditors Association s Best Practices for Contracting Services: Contract monitoring is an essential part of the contracting process. Without a sound monitoring process, the contracting agency does not have adequate assurance it receives what it contracts for. To properly monitor the contract, the agency should assign a contract manager with the authority, resources and time to monitor the project. (Emphasis Added) RECOMMENDATIONS: The Commission should assign someone to monitor the contract in accordance with state laws and regulations and the contract terms. AGENCY RESPONSE See page 18 for the Commission s response to this finding. 14

23 MATTERS FOR CONSIDERATION

24 MATTERS FOR FURTHER CONSIDERATION During the course of an audit, Office of the State Auditor staff may uncover potential issues that are outside of the audit objective. Although the issues may not have been part of the planned objective, the issues need to be presented to those charged with governance of the organization under audit. Below is such an issue. Commission Did Not Assist in Obtaining Contractor Documentation The Alcoholic Beverage Control Commission (Commission) provided the Office of the State Auditor (OSA) with limited assistance in obtaining documentation necessary to perform audit procedures from LB&B Associates, Inc. (LB&B). As administrator of the Alcoholic Beverage Control Commission Warehouse contract (Contract), the Commission is responsible for monitoring the performance of LB&B in accordance with the terms and conditions of the Contract. This would include, requesting and inspecting documentation from LB&B on a regular basis. Upon notification that OSA was considering a subpoena to obtain records from LB&B, the Commission s Chief Administrator stated that the issue was between OSA and LB&B. It should be noted that documentation requested by auditors were those that the Commission should be requesting from LB&B as part of their ongoing oversight and monitoring responsibilities. Ultimately, OSA was able to obtain the majority of records and documentation requested by working with LB&B directly and a subpoena was unnecessary. 15

25 APPENDIX

26 16 APPENDIX

27 STATE AUDITOR S RESPONSE

28 STATE AUDITOR S RESPONSE The Office of the State Auditor (OSA) is required to provide additional explanation when an agency s response could potentially cloud an issue, mislead the reader, or inappropriately minimize the importance of the auditor findings. Generally Accepted Government Auditing Standards state, When the audited entity s comments are inconsistent or in conflict with the findings, conclusions, or recommendations in the draft report, or when planned corrective actions do not adequately address the auditor s recommendations, the auditors should evaluate the validity of the audited entity s comments. If the auditors disagree with the comments, they should explain in the report their reasons for disagreement. Poor Contract Administration Cost the State At Least $11.3 million Over 13 Years The Commission s response stated It is our understanding that negotiations and amendments were reviewed by the NC Attorney General s Office This response could mislead the reader to believe that the NC Attorney General s Office review provided validation for: Exceeding the maximum allowable Contract price by $11.3 million over 13 years Approving $5.5 million in contractor requested price increases without verifying reasonableness and necessity Exceeding the three-year contract term limit four times without proper review and approval Consequently, the reader could also misunderstand the extent of the review performed by the Attorney General s Office. The NC Attorney General s Office did not review the Commission s contracts to ensure that price increases were warranted or supported. As required by statute, 1 contracts and amendments submitted to the NC Attorney General s Office were reviewed only to ensure that the proposed contracts/amendments are in proper legal form, contain all clauses required by law, are legally enforceable, and accomplish their intended purposes. Additionally, in 2014, a law was enacted that requires the Secretary of the Department of Administration (DOA) to notify the NC Attorney General s Office of pending contracts for contractual services exceeding a cost of $5 million. 2 Upon notification, the NC Attorney General s Office is required to assign a representative to assist in the negotiation for the award of the contract. The review should assist in obtaining the most favorable contract for the State and to evaluate all proposals available from prospective contractors for that purpose. The Commission only executed one contract amendment after 2014, which was a November 2016 contract amendment that approved price increases through However, the Commission did not provide evidence that the amendment was reviewed by the NC Attorney General s Office for the required assistance, review, and evaluation. The Commission contends that their contracting activities are exempt from the DOA s oversight. OSA does not agree with the Commission s interpretation of the law. But regardless of interpretation, the statute specifically requires any contract exceeding the cost of $5 million to be reviewed and evaluated by the NC Attorney General s Office. This includes contract proposals by any agencies that are exempt from DOA oversight. 1 2 North Carolina General Statute (a). North Carolina General Statute (3a). 17

29 RESPONSE FROM ALCOHOLIC BEVERAGE CONTROL COMMISSION

30 RESPONSE FROM THE ALCOHOLIC BEVERAGE CONTROL COMMISSION 18

31 RESPONSE FROM THE ALCOHOLIC BEVERAGE CONTROL COMMISSION 19

32 RESPONSE FROM THE ALCOHOLIC BEVERAGE CONTROL COMMISSION 20

33 ORDERING INFORMATION COPIES OF THIS REPORT MAY BE OBTAINED BY CONTACTING: Office of the State Auditor State of North Carolina 2 South Salisbury Street Mail Service Center Raleigh, North Carolina Telephone: Facsimile: Internet: To report alleged incidents of fraud, waste or abuse in state government contact the Office of the State Auditor Fraud Hotline: or download our free app. For additional information contact: Brad Young Director of External Affairs This audit required 4,257 hours of auditor effort at an approximate cost of $438,